With its stock down 33% over the past three months, it is easy to disregard Yunnan Energy New Material (SZSE:002812). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Yunnan Energy New Material's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Yunnan Energy New Material is:

7.4% = CN¥2.1b ÷ CN¥29b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Yunnan Energy New Material's Earnings Growth And 7.4% ROE

At first glance, Yunnan Energy New Material's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.4%. Particularly, the exceptional 30% net income growth seen by Yunnan Energy New Material over the past five years is pretty remarkable. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Yunnan Energy New Material's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.7%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Yunnan Energy New Material fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Yunnan Energy New Material Using Its Retained Earnings Effectively?

Yunnan Energy New Material's three-year median payout ratio to shareholders is 8.4%, which is quite low. This implies that the company is retaining 92% of its profits. So it looks like Yunnan Energy New Material is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Yunnan Energy New Material has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 21% over the next three years. However, Yunnan Energy New Material's future ROE is expected to rise to 10% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, we do feel that Yunnan Energy New Material has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com